Baidu: Factors Driving Our $125 Valuation

Baidu (NASDAQ:BIDU) is China’s largest search engine with around 80% market share in the country. The company has quadrupled its total revenues from $469 million in 2008 to $2.3 billion in 2011. This rapid growth continued during 2012 as Baidu posted revenues of around $1 billion in Q3 2012, a year-over-year increase of approximately 50%.

Overall, we think that Baidu is in a good position to capitalize on the increase in online ad spending in China, primarily because of its dominant position in the search market. However, the increasing competition among search engines could cause growth to slow as it could put pressure on its market share and revenuer per search metrics.

Baidu’s search advertising business is the biggest contributor to its overall value at approximately 60%. This division generated 60% of Baidu’s revenues in 2011, and we think this proportion will increase to around 65% by the end of our forecast period. Baidu’s search revenues over the past three years have skyrocketed, in part due to Google’s troubles in the Chinese market, which culminated in the firm’s exit from China in 2011. Google’s exit essentially gave Baidu a monopoly on the Chinese search market, a position that could wane as new competitors such as Qihoo gain traction in the industry. [1]

If Qihoo’s search engine is able to grab a chunk of the market from Baidu, it could lead to lower revenue per search (RPS) growth for the company, which was at $5 in 2011 and is expected to reach $8 by the end of our forecast period. We think that RPS could slow down primarily because of the increase in choice that advertisers have in deploying their advertising dollars, meaning that Baidu will no longer have the pricing power it has had over the past two years. You can use our tool below to assess the impact that a slowdown in Baidu’s RPS growth will have on the company’s value.

Display Advertising is Key For Diversification of Revenues

Baidu’s display advertising segment is its second biggest operating segment, contributing approximately 25% of its total value. In our opinion, revenues from this segment are key for Baidu’s long-term stability as they will reduce Baidu’s reliance on search revenues. At present, display ads have a much lower monetization rate than search, generating $0.50 per 1,000 page views, with around 300 million Chinese internet users visiting Baidu.

We forecast that revenues from display ads will increase to around $2 billion by 2016, up from around $700 million in 2011. We think this increase will be driven by the increase in the number of users on Baidu’s sites (which we think will be around 500 million by 2016) and improved monetization on their display ad properties.

Mobile monetization is key for long term growth

Baidu has approximately 35% market share in the Chinese mobile search market, which is much lower than its share in PCs and desktops. [2] The mobile opportunity is one area where Baidu will focus on in the coming years, but the smaller market share compared to its PC offerings could leave the company in trouble. We think Baidu has taken some good steps in this space such as launching its own mobile OS and browser, which will help it gain market share among mobile users. Overall though, we will have to wait and see whether or not Baidu is successful at monetizing its mobile user base in the next 2-3 years.

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